Lower Taxes in Retirement?
Submitted by Larry Frank Sr. on Mon, 04/21/2014 - 3:00pm
Like many, you might think, “Why save so much for retirement when my
taxes will be much less?” This supposed truth is a myth, a recipe for
financial disaster in your golden years.
Let’s start with your tax return. First, the top total earnings line
does not include what you contribute to your401(k), 403(b) (for school and
tax-exempt organization employees), 457 (for employees of state and
local governments and tax-exempt governments and employers) and
other individual retirement plans.
You may think that because you contribute toward retirement, say 15% of
your salary, in tax-free or tax-deferred accounts, your taxes or taxable
income drops 15% when you retire. Wrong: You pay taxes throughout life
on your standard of living level, the money you earn and spend.
(You do get a break in retirement from no longer paying into Medicare and
Social Security; eventually Social Security also helps support your
retirement standard of living. Don’t reduce standard of living for Medicare
when calculating for retirement because you will need funds to continue to
co-pay for health care once you retire.)
The income tax rates below show how much you need to reduce spending
to get into a lower tax bracket and to what degree higher brackets actually
hit your wallet. See, for example, that even if you enter a higher bracket,
all your money below that upper bracket’s trigger point gets taxed at
the lower rate – only the money over that trigger amount incurs the higher
Let’s say you file taxes as single and your taxable income hits $90,000.
Your tax (estimated for the 2014 tax year) is $18,193.75 plus 28% of $650
(that dollar figure is the difference between your $90,000 and the bracket
trigger amount of $89,350), or only $182 in extra tax. Contrast that with
how much you need to reduce your taxable income all the way to less
than $36,900 to reduce your tax rate to 15% (as you see in the third left-
Only if you are on the cusp with your taxable income does spending less
change your tax rate; most people I see are well within their bracket or
near the top of it. Look at where you sit in your bracket. If in the upper
part of your bracket, you must cut your spending quite a bit to lower your
Beware: You may need to cut spending at retirement if you don’t save
enough. Save more now toward what you need to sustain your present
standard of living. Saving more also generally means spending less.
Saving more feels better than cutting spending – even though the effect
is the same – because saving more feels like accomplishment. (Cutting
spending often just feels like denial.) If you keep your present standard
of living in retirement, your taxes remain the same, too.
For an idea of your likely retirement standard of living, calculate your
current standard of living based on expenses and income and deduct
what you pay into Social Security. Most important, plan on paying taxes
in retirement a lot like you pay today.
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Larry R. Frank Sr., CFP, is a Registered Investment Adviser (California)
in Roseville, Calif. He is the author of the book, Wealth Odyssey. He has
an MBA with a finance concentration and B.S. cum laude in physics with
which he views the world of money dynamically. He has peer-reviewed
research published in the Journal of Financial Planning.
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